Wealthfront: A Front for Mediocrity
Daniel Drew, 12/16/2014
Wealthfront is like that old ugly sweater your mom keeps wrapping up every Christmas and giving to you as a joke - except this joke isn't $19.99. It's $1 billion and counting.
Andy Rachleff started Wealthfront in 2008 - a great year to start an investment advisory service. Wealthfront is a Palo Alto-based millennial reincarnation of the old index investors of the 1970s. It's a Burton Malkiel project that funnels business into Vanguard.
For the uninitiated, Malkiel wrote a famous book called A Random Walk Down Wall Street in 1973. The book is nearly 500 pages and has 9 editions to reassure you that it is still valid. The entire book in two sentences: The stock market is a crapshoot anyway, so let's buy everything. They can't all go to zero. And thus, the ideal of mediocrity was born.
It used to be that we were taught to strive, to be competitive, to be the best. But then a trend started. I'm not sure exactly when. Previously, only winners received trophies. Eventually, everyone became a winner, and everyone got trophies. Participation awards were invented. People stopped playing poker and started playing bingo. And people started buying index funds.
Yes, it is true that most fund managers do not beat the benchmark, but at least they're trying. They are not content with receiving a participation trophy - unless they're mutual fund managers - who get paid no matter what happens.
At Wealthfront, the definition of successful investing is blindly buying 500 stocks and hoping they go up. Also, you will be subject to historical drawdowns of 50% - which is the nice way of saying that at some point in time, you will lose half your money. This is supposed to be innovation.
The only real innovation at Wealthfront is daily tax loss harvesting. Instead of owning just an ETF, you also get to own small amounts of individual stocks, which allows this daily tax loss harvesting to take place. Wealthfront calls their method direct indexing. They proudly announce that this could add 1% to your account every year. To make it sound like a bigger deal, they say it could compound to 50% after 20 years. That would be great news if my life span were 2,000 years.
The train wreck continues as they say their method is based on modern portfolio theory, which denies the alchemy of finance and turns it into rocket science. It starts off with a simple enough proposition: don't put all your eggs in one basket. This is helpful advice in the normal world, but in finance, it is not only useless - it is dangerous.
Diversification provides a false sense of security because you think you have put your eggs into different baskets. In the stock market, when the wolf comes, your 10 baskets merge together into 1 single large basket, with a welcome mat for the wolf. During times of crisis, correlations go to 1, and everything falls together in beautiful harmony, like the 4th movement of Beethoven's 9th symphony - except the conductor is Wall Street, and the song is Ode to Failure.